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Starting a business

Diversification strategy: Definition, examples, and tips

A successful diversification strategy can help boost your new business and provide the growth and competitive advantage it needs. This can be especially useful if you’re trying to diversify your product offerings and branch out into a new business space. Executing this strategy well can help increase your business’s profitability and the overall success of your brand. 


Read on to explore what diversification is, the various types, as well as real-world examples and tips to help you choose the right strategy for your small business. 





What is diversification strategy?

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Diversification strategy is when a business will expand into more markets by offering new products or services. This type of strategy can help businesses that are struggling or further boost the success of businesses that are already profitable. 


There are four main reasons why businesses seek to adopt a diversification strategy, including: 


  • The business wants to become more profitable 
  • The business’s core offerings are struggling 
  • The business wants to boost their brand image
  • The business wants to protect itself from competition 


A diversification strategy can be a great way to kick-start a small business or can help further boost the success of a business. 


4 types of diversification strategies

types of diversification strategies with green icons

There are four key types of diversification strategies that are commonly used, including: 


  • Horizontal diversification
  • Concentric diversification 
  • Conglomerate diversification
  • Vertical diversification


Read more below for an in-depth look at the different types along with examples.


1. Horizontal diversification

Horizontal diversification refers to the creation and development of new products that are tangentially related to your original product offerings. A company will then conduct market research to decide whether or not it will need to begin manufacturing new resources.  


Best for: Small businesses that are competing in a saturated market or where market share is finite


Pros: 

  • Can help expand your marketing reach since you’ll have access to more industries 
  • Could help with overcoming any competitive challenges faced due to industry consolidation
  • Has the potential to create economies of scale and scope


Cons:

  • Quick growth too soon could deplete your resources 
  • Could lead to legal repercussions since this strategy can lead to a monopoly, which is discouraged by many governments 
  • Reduced flexibility since your company will be larger as a result

Horizontal diversification example

If you’re a company or small business that started out just selling computers, you may use horizontal diversification to start selling other related products, such as phones and accessories. 


2. Concentric diversification

Concentric diversification is the strategy of expanding into new services or product offerings that are similar to what you already have. Businesses that take advantage of this strategy are able to leverage current processes and resources that are already in place.   


Best for: Small businesses that have underutilized resources or are facing a downturn in their industry 


Pros: 

  • Allows for the use of current processes and practices
  • Enables business synergy 
  • Can help boost market share


Cons:

  • Implementing too soon could be too much to handle 
  • May require additional resources outside of the current staff 
  • Can be harder to adapt to current market changes 

Concentric diversification example

This strategy would apply to a company that begins to sell orange juice with pulp in addition to pulp-free orange juice, or a pizza company that starts selling mozzarella sticks in addition to their standard pizzas. 


3. Conglomerate diversification

Conglomerate diversification is a strategy that aims to incorporate a new service or product that is different from the original offerings. Unlike horizontal diversification, these offerings are usually unrelated to the original offerings.  


Best for: Small businesses that operate in seasonal industries or have strong brand recognition  


Pros: 

  • Can provide a unique stream of revenue 
  • Makes use of potentially underutilized resources
  • Can attract new audiences to your brand


Cons:

  • Could potentially dilute your existing brand
  • The cost of entry could use up profits that you made with your existing product
  • Brand recognition may not be strong enough to endure crossing over into new markets

Conglomerate diversification example

The most popular example of this strategy can be seen with Virgin, which first began in the music industry. They then switched to the airline industry, then onto cellular services as well as others. 


4. Vertical diversification

Vertical diversification is when a company expands either backward or forward on the production cycle to either lower dependence on a supplier, cut costs by utilizing current resources, or raise profit. Essentially, using this strategy leads to acquiring a supplier or a customer. This strategy is also known as vertical integration. 


Forward diversification allows for greater control over distribution since the company chooses its own outlets to create direct contact with its customers. Backward diversification occurs when a company starts to produce its own raw materials versus getting them from a supplier. 


Best for: Small businesses that are more reliant on their suppliers and are at a higher risk of supply shortages due to an unreliable supply chain


Pros: 

  • Makes it easier to expand globally since you have the power to choose your distribution centers
  • Helps maintain quality control since you choose your suppliers   
  • Less dependency on suppliers if you choose to produce your own materials


Cons:

  • May be easy to underestimate the cost and difficulty of the process 
  • Reduced flexibility because of the upstream and downstream investments you’ll have to make   
  • Expensive because the initial costs can be significant  

Vertical diversification example

An example of forward vertical diversification is a beverage company that acquires a firm that installs and maintains vending machines. Backward diversification, on the other hand, could be a car company that begins to produce its own parts.

Risks related to diversification strategy

There are a few risks associated with diversification strategy. There are three different types of risks to be aware of before implementing a new strategy


  1. Decision risk: Means and choice of diversification could turn out wrong 
  2. Implementation risk: Processes, systems, structure, talent, and leadership might not be strong enough 
  3. Financial risk: Return to stockholders might be reduced


Before any diversification strategy plans are made, there are three different tests you can perform, including: 


  • Industry attractiveness test: Ask yourself if the entry business is high, if the new industry is conducive to growth, and if the competitive conditions are favorable. 
  • Cost of entry test: Figure out if the cost of entry is low, the cost of specific equipment, and if there are any obstacles to entering the market. 
  • Better off test: Become aware of what synergy exists with ongoing operations and ask yourself if brand equity can be leveraged. 


Becoming aware of the diversification strategy risks and asking yourself the questions above can help you become better prepared to make a strategic decision for your business.

Lessons from successful (and failed) diversification strategies

diversification tips and a hand holding a green box with a yellow lightbulb coming out of it

Diversification strategies have been implemented by many brands and companies—some successful, some not. Here are lessons from both successful and failed strategies, along with tips to help you choose the best strategy for your company. 


Be realistic about product appeal

When it comes to diversification, knowing how you stack up against competitors is important. If you’re introducing a new product that is similar to one that a bigger company also offers, you may not be successful. 


For example, Virgin Atlantic airline made the decision to launch Virgin Cola in 1994, going up against cola beverage titans Pepsi and Coca-Cola. This brand switch ultimately failed as the competition was too steep and there wasn’t enough positive feedback from consumers. 


Bottom line: Research market saturation.


Ensure your product has a legitimate purpose and appeal

Another tip is to ensure that the product you’re diversifying serves a purpose that has a broad enough appeal to your audience. 


For example, in 2014 Google launched a new product called Google Glass, which were smart glasses with a built-in computer. However, the product was discontinued after two years due to lack of appeal, poor manufacturing, and privacy concerns. 


Bottom line: Invest in proper market research.


Stay aware of potential brand clashes

It’s important to be aware of whether or not it makes sense to expand your brand into another market, since this has the potential to disrupt your original target audience. 


For example, Colgate launched a line of frozen meals in the ‘80s, but the new product clashed with their original offering of dental care, didn’t receive much praise from their new customers, and ultimately flopped.


Bottom line: Avoid offerings that contradict your core purpose or values.


Prioritize operational synergy

If you plan on diversifying with new product lines, ensure that you prioritize operational synergies in manufacturing. 


For example, Apple branched out from its original offering of computers to different types of electronics such as phones, watches, and tablets. This was successful because of the operational synergy they achieved—between the various product lines, Apple was able to share resources and capabilities between the market lines.


Bottom line: Utilize existing connections and resources.


Diversify and grow your business 

With strategic planning and business development set in place, diversification can help you take your brand to the next level. Be sure to do your due diligence and gather the information you need before choosing the right diversification strategy for your business. 


To simplify your business growth even further, be sure to utilize tools like QuickBooks to help you implement diversification and take tasks off your plate.


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